Are We Witnessing the Demise of the Dollar?

Oct. 6, 2009— -- Is the dollar's status as the world's reserve currency in jeopardy? How are U.S. officials responding? And should the average American be worried?

A report in The Independent newspaper today, citing Gulf Arab and Chinese banking sources in Hong Kong, said that Gulf Arab countries -- joined by China, Russia, Japan and France -- are planning to move away from pricing oil in dollars to using an array of currencies including the Japanese yen, the Chinese yuan, the euro, gold, and a new unified currency in the Gulf Co-operation Council including Saudi Arabia, Abu Dhabi, Kuwait, and Qatar.

Asked about this report today, a Treasury Department official had no comment. However, U.S. officials have been vocal in recent weeks about emphasizing their confidence in the dollar.

"A strong dollar is very important to this country. I mean that, and it's very important that people recognize it," Treasury Secretary Tim Geithner said last week at the Newseum in Washington.

"It does bring special responsibilities and burdens on the United States and it is very important that we make not just Americans but make the world understand that we are going to go back to living within our means. And that we are going to make sure that our independent Federal Reserve keeps inflation low and stable over time," he said.

Earlier that day at a House Financial Services committee hearing, Fed chief Ben Bernanke stated flatly that there was "no immediate risk" to the dollar.

The central bank chairman was responding to a lawmaker's question about World Bank president Robert Zoellick's comments earlier last week that the United States should not "take for granted" the dollar's status because it will be challenged in the future by a growing number of other options.

"I agree with two things Mr. Zoellick said," replied Bernanke. "The first is, I believe he said that there is no immediate risk to the dollar -- this is a relatively long-term issue. I also agree with him, though, that if we don't get our macro house in order, that that will put the dollar in danger and that the most critical element there is long-term fiscal stability."

At the G-20 summit in Pittsburgh in September, Geithner also stated his faith in the dollar.

"A strong dollar is very important in the United States," he told a press conference Sept. 24. "We have a special responsibility here in the United States to make sure we are doing the things in this country to preserve confidence in the U.S. financial system, confidence that's very important to sustain the dollar's role as the principal reserve currency in the international financial system. And we expect, as I think countries around the world expect, the dollar to retain that position for a very long time."

Meanwhile, a number of the countries cited in The Independent report are publicly refuting the story today.

According to Bloomberg News, Saudi Arabia's Central Bank Governor Muhammad al-Jasser called the report "absolutely incorrect" and said "absolutely nothing" of that nature has been discussed between the world's largest oil exporter and other countries.

Kuwaiti Oil Minister Sheikh Ahmed-Al Abdullah said in Kuwait City that Gulf Arab countries have no plans to ditch the dollar in oil pricing. Russia's Finance Ministry is not holding talks about the issue, according to an Interfax report citing Deputy Finance Minister Dmitry Pankin.

Also, Algeria's Finance Minister Karim Djoudi told Reuters, "I don't see a need for oil trade to be denominated differently."

Currently, many officials are gathered in Istanbul for last week's G-7 meetings and this week's meetings of the International Monetary Fund and World Bank.

On Tuesday, a United Nations official said a new global reserve currency would help retract the United States' "privilege" of running up a massive trade deficit.

"Important progress in managing imbalances can be made by reducing the reserve currency country's privilege to run external deficits in order to provide international liquidity," said the UN's under-secretary general for economic and social affairs Sha Zukang.

Eswar Prasad, Cornell University's senior professor of trade policy, told ABC News today that the dollar's status is "fragile" but it is "not quite in demise yet because there is not a clear strong alternative."

Some possible alternatives would be the Chinese yuan, known as the renminbi, the currency for the most populous nation, and the euro, the world's most actively traded currency after the dollar.

Prasad said the average American should "definitely be worried" if the dollar loses its position as the world's reserve currency.

"If the dollar maintains that status and the rest of the world is willing to accept dollars and buy dollar-denominated bonds issued by the U.S. government, then essentially it allows the U.S. government to partly finance its operations through financing provided by other countries," Prasad told ABC News.

"If the dollar did not have that status, it would be much harder for the U.S. government to run large deficits because all the bonds would then have to be purchased by U.S. residents, which would drive up interest rates and thereby affect the average American."

"If you are the average Joe, you should definitely be worried because if the U.S. dollar loses its status it is going to mean higher borrowing costs for the U.S. government, which will mean the average Joe will have to pay higher taxes, the U.S. government will spend less on services, and there will be higher interest rates -- or some combination of the above."

John Williamson, a senior fellow at the Peterson Institute for International Economics in Washington, said the demise of the dollar is hardly imminent.

"I don't think it's true in any imminent sense," he stated. "If we're talking 50 years, it may be true. If we're talking the next two to three years, I don't think it's realistic."

Williamson noted that there are two schools of thought among economists on this issue.

"Some think it really wouldn't have any major impact. Others think the impact of the reserve role of the dollar is quite important, quite fundamental, to allow it to run up the types of deficits it's run in real years. I'm in the school that tends to think it's less essential to keep the dollar as reserve currency."

One fear, he observed, was that the leading foreign holders of U.S. government debt, China and Japan, would elect to hold assets from other countries instead.

"I doubt it makes that much of a difference," Williamson said. "They'd have to decide to hold something else instead. The euro is realistic to some extent. The renminbi would doubtlessly become realistic. But I don't think that there's a realistic alternative right now."